Owners who want to transition out have options to explore, and while none are easy, they all have benefits.
Ford. Phillips. Mars. Businesses known by the family name and passed from one generation to the next are becoming fewer in number, creating unexpected challenges for business owners ready to retire.
“Fifteen years ago, it was just assumed that the next generation would assume control of the business. That’s definitely not the case now,” says Mike Ella, director of family wealth consulting at KeyBank in Cleveland. Most often, there is no next-generation family member who can or wishes to take the helm. And some business owners don’t want to force sons and daughters into the role, opting to use funds to help them invest in a new venture, Ella says. “The entrepreneurship is passed on, rather than the actual business.”
Flyers Pizza CEO Steve Ulrey, 68, started thinking about a succession plan five years before executing one via an employee stock ownership plan in 2016. It took that much time to thoroughly explore the options and execute the complex ESOP. “A lot of companies fail with the third generation,” says Ulrey, whose father Wayne founded Flyers in 1976. “We weren’t going to force my sons or wait until they were old enough” to grow into the business. Another option was a buyout involving Ulrey’s three brothers, but the cost of paying him the company’s value would have hindered company growth.Stay up to date with the region’s thriving business scene. Subscribe to Columbus CEO’s weekly newsletter.
Ulrey says the family didn’t know about ESOPs, but “the more we heard about, the more we liked. It gave us funds, gives employees a piece of the company and eliminated federal business tax.” The strategy is not for everyone, he cautions. It took more than a year, $400,000 and a lot of hard work. “It’s difficult,” he acknowledges. “You’re trying to run a business and you’re fielding calls every day” about the finer points of valuation and other specifics.
Family business owners who want to successfully transition the company need to be as thorough as Ulrey, succession experts agree. “Don’t rush it if you don’t have to. This really is a very difficult and challenging task,” says Joel Guth, CEO of Gryphon Financial Partners in Columbus. “We have seen people hang on longer than they should have or wanted to.”
When it comes to transition options, business owners have several to consider besides an ESOP, which is among the most complex. Others include:
Third-party sales, either to private equity or strategic buyers, most likely competitors or those with business synergies. Such was the case when Columbus-based Ricart Automotive purchased the A.D. Farrow Harley-Davidson dealership last year. Farrow owner Bob Althoff’s children weren’t in the business, so he decided to sell to a well-known family enterprise with a complementary market. Alfred D. Farrow founded the motorcycle business in 1912.
Internal transitions, where a business grooms someone already in the company to assume ownership. This can take several years because of the time needed to integrate the person into all aspects of the business and see how both employees and customers respond. Guth says he knows of instances when the family decided after a period of transition, “this isn’t the right person” and re-booted the succession plan.
External transitions, or hiring someone outside the company to assume the ownership role over time. Earned buyouts are a way to transition both responsibility and reward as the seller receives future payments based on business performance.
The rise of private equity and available capital can make selling outright safer than transitioning, which involves a lot of unknowns, Guth says. “It can make more sense financially and protects the family, which often is very dependent on that business being financially successful.”
Any type of sale outside the family is difficult because, “no matter how diligent your search, you will never know until they’re in place. It’s important that there’s a culture fit,” Guth says. If specific philanthropy, brand image or other objectives are critical, family business owners should be willing to consider a lower price to achieve those, he adds. “The more restrictions you place on the buyer, the more you restrict your sale price and your market.”
Other factors affecting price and market appeal are owner dependency, customer concentration and management depth, Ella says. “If the owner wants to exit the day of sale, that can have a huge impact for some potential buyers, and if one client accounts for more than half the company business, that also can lower the value.”
Conversely, owners can hike company value by agreeing to deferred compensation or another arrangement that rewards them for staying on for a specified length of time.
Besides the more mechanical considerations, the emotional makeup of family business owners presents one of the larger challenges in succession planning. Someone who has created or inherited a family business, grown it and shepherded its wealth has a powerful connection to it, Guth says. “Your identity is tied up in that business. Where do you find fulfillment? For many entrepreneurs, it was in the business.
“For 12 to 18 months, it’s utopia. You don’t have to go in every day, you travel, you have liquidity,” Guth says. “Then you wake up one day and ask, ‘I have 60 hours of free time a week that I didn’t have before. Now what do I do?’ ”
He knows of owners whose quality of life actually diminished when they stepped away entirely from the business.
Guth urges owners to bring in experts such as industrial psychologists to delve into all aspects of the move. “Surround yourself with key advisers who’ve had direct experience with this. Get input,” he says.
Family wealth experts also tell owners to give themselves enough time. Sales can take anywhere from several months to nearly three years, and internal transitions tend to be lengthier. ESOPs require the most effort.
While the seller market is hot right now, economic uncertainty makes timing critical, Ella says. “For owners who can wait four or five years, there’s probably not too much to worry about. If you want (or have) to sell in the next one to three, I would push to do it now.”
Family business successions have many moving parts, not the least of which is the family itself, Guth says. That’s why parents and children must have ongoing and clear communication with one another so the third generation doesn’t feel duty-bound to carry on when that expectation doesn’t actually exist. “The last thing you want is to impact the family dynamic negatively,” Guth says, “and that’s a complicated thing.”
Laurie Allen is a freelance writer for Columbus CEO.